Despite the success of microfinance that hinges on group lending - which has been profitable for MFIs and beneficial particularly for the rural poor, there are increasing reports that local NGO MFIs subcontracted by a multi-million-dollar microfinance programmes are taking bribes from the borrowers.16 While there are increasing calls to launch financial governance on these NGO MFIs, many would worry how corruption of this nature can damage MFIs’
contributions to the credit market, particularly in the bank-linkage programme where the NGO MFIs act as third party intermediary. Our study analyzed the corruption decisions faced by MFIs and the impacts on the bank-linkage programme as a solution to release the information problems in the credit market. Our results show that in a linkage between MFI
15See Premchander (2003) for the institutional arrangements with regard to agriculture and rural credit.
16See http://www.speroforum.com/a/17580/Microfinance-industry-breeds-corruption.
and bank, even when there is a possibility of corruption between MFI and the borrower, the probability that the borrower puts in full effort will increase, and both the probabilities of credit rationing and strategic default will decrease.
In the light of the potential for growth in the rural sector, micro-financing can be more effective in poverty reduction, if commercial banks become inclined to channel their asset portfolio in financing viable projects in rural areas via the MFIs in the loan approval and monitoring process - a link suggested in this paper between formal banks and the rural borrower. This will strengthen the already existing evidence that access to microfinance contributes to poverty reduction (see Khandker, 2005). The banking system is still out of reach for the poor as they cannot bribe a loan officer or provide collateral that the banks need in order to provide them with a loan. Thus MFIs can act as an intermediary in a bank-linkage programme that would allow the poor to access the credit market so as to reduce their poverty on the one hand and to achieve an overall financial sector development on the other. The productive economic activities in the rural areas should be the determining factor for credit allocation. Change in government priorities to enable developing rural financial markets along this direction can therefore help remove the financing constraints facing the micro-entrepreneurs and small-businesses, and thereby provide a direct link between financial development and poverty reduction.
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